The electronic ticker display outside the Toronto Stock Exchange Tower in Toronto, on Jan. 24.Christopher Katsarov/The Globe and Mail
J. Ari Pandes is an associate professor of finance at the University of Calgary’s Haskayne School of Business. Bryce C. Tingle, KC, is the N. Murray Edwards Chair in Business Law at the University of Calgary’s faculty of law.
In 2021, 33 operating companies each had an initial public offering on the Toronto Stock Exchange. Pundits proclaimed, “The IPO market is back!” What a difference a year makes. To date in 2022, only one operating company has joined the TSX, and it was really a secondary sale related to a spinoff.
The stark drop in the number of IPOs this year is no surprise to us. This reflects not just wider economic conditions of higher interest rates and talk of a looming recession.
The reality is that the IPO market has been quietly declining for some time, which we first documented in a 2013 research paper, followed by another research paper in 2021 with updated data. We noted that from the period 1993 to 2000, the TSX had an average of 41 IPOs a year, and in the period since, 2001 to 2021, there have been an average of just under 15 IPOs a year. The best years since 2000 did not come within striking distance of beating the average number of IPOs in the 1993-to-2000 period.
The lack of IPOs helps explain the shrinking number of public companies in this country. This is not a uniquely Canadian phenomenon. The United States and most other developed economies have experienced a similar decline.
You won’t notice the decline if you look at the top-line number of public listings on the TSX, which increased steadily from 1,340 in 2002 to 1,749 in 2021. But closer examination reveals an alarming fact: The TSX is increasingly comprised of financial products such as exchange-traded funds (ETFs) and closed-end funds.
Indeed, the exchange hit a key inflection point in 2020, and the number of ETFs and closed-end funds now exceeds the number of operating companies on the TSX. In other words, the majority of public listings today are not the companies most people think of, which are businesses that invest, innovate, produce goods or services, and employ workers.
The decline of the public markets – and IPOs – seems like a remote problem for most Canadians, but it may go to the heart of what is arguably the biggest economic policy issue in the country: our declining relative innovation and productivity growth. Our relatively poor economic performance over the past several decades has led to a declining relative standard of living, and it is a bit of a surprise.
Canada has an enormous advantage in the raw inputs required for innovation. On a per-capita basis, we have some of the highest rates of entrepreneurship, research outputs and educational attainments in the world. We generally have a very favourable tax regime for innovative businesses, and almost unfettered access to the world’s largest markets. How are we failing?
Young companies need a place to grow, scale up and become national champions in sectors in which Canada desperately lags, such as technology, pharmaceuticals and biotechnology. These homegrown companies can then become fertile breeding ground for the next crop of innovative entrepreneurs.
The technology scenes in the Waterloo and Ottawa regions would not have become what they are today without BlackBerry and Nortel. Multiple teams of researchers have discovered that while Canadians do create innovative companies, they often sell them – usually to foreign buyers – before the startups grow very large. Canada has what economists call a “scaling” problem.
Our research shows that for the past 22 years, entrepreneurs and investors have no longer chosen a public listing as their preferred path to exit. This means our most dynamic businesses become part of larger companies too early. These larger companies are almost always foreign, because in most advanced industries, Canada has few big companies that might serve as purchasers.
Over the past couple of decades, securities regulators and policy makers spent a lot of time delicately fine-tuning and liberalizing the private (exempt) capital markets. This has created greater access to capital for growth companies while balancing needs for investor protection.
Meanwhile, the public markets have become noticeably higher-maintenance and unpleasant for public company managers, who must deal with an ever-increasing laundry list of one-size-fits-all or check-the-boxes governance best practices. We have discussed a vast body of empirical research that consistently shows these so-called best practices have little or no empirical effect on corporate performance, or anything else issuers and investors care about. Much of what Canadians have done in our public markets thus represents a dead loss to issuers.
High-quality markets are designed to attract buyers and sellers. Canada has plenty of buyers of public corporate shares; the growth of ETFs on the TSX is proof of that. What we lack in our current public markets are incentives for the sellers of corporate shares – operating companies – to enter the market.
In theory, fixing this should not be hard. Just over 20 years ago, most entrepreneurs running successful and fast-growing private companies wanted to go public. This would let them keep their jobs and build out their vision for the business.
Now, we have a public market most entrepreneurs tell us they do not want to join. They would sooner sell out early, lose their jobs and do something else with their lives.
The reforms Canada has made to private markets have balanced giving companies access to capital with protecting the public.
No such balancing of interests is visible in the way we have regulated and restructured our public markets. We have piled mandates, disclosure obligations, dubious best practices and dysfunctional oversight mechanisms onto public company managers, without much consideration of what that does to their willingness to expose themselves and their companies to the resulting environment.
It is time for regulators, stock exchanges and even institutional shareholders to start experimenting with reforms to our public markets that might incentivize Canada’s entrepreneurs to stay in the country and build their companies here.